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July 30, 2012

Draghi, With Credibility at Stake, Ups Ante in Debt Fight

ECB president pushes for cheaper lending to Spain, Italy

After European Central Bank (ECB) President Mario Draghi said last week he would do “whatever it takes” to preserve the euro, he’s upping the ante by pushing both central bankers and political leaders in the joint currency bloc to agree to take drastic action to cut borrowing costs for Spain and Italy before an ECB policy meeting on Aug. 2.

Bloomberg reported Monday that as the debt crisis continues, Draghi hopes to quell market jitters that have sent bond yields steadily higher for the two countries considered next in line for possible bailouts. If he fails to win over other leaders in the eurozone, a bond market selloff could result in the sundering of the euro.

At the heart of his efforts, according to two ECB officials with knowledge of the plan, is the purchase of government bonds on the primary market by the region’s temporary bailout fund, the European Financial Stability Facility (EFSF). That would be backed by the ECB stepping in on the secondary market to make additional purchases and ensure the preservation of its low interest rates.

In addition, further rate cuts by the ECB and more long-term loans to banks are being considered as part of the strategy.

Moody’s Investors Service said in the report that while the ECB’s willingness to act is necessary to buy time, it cannot solve the crisis by itself. And the central bank may have a tough time persuading Germany’s Bundesbank to plunge in—just last week the central bank reiterated its opposition to bond buying, saying that such an action crosses boundaries that separate monetary policy from fiscal policy.

Although Germany has insisted that other countries must surrender sovereignty over their banks and budgets in order to receive bailout money from common funds or to set up joint euro bonds, it has resisted doing so itself. In fact, during stress tests on financial firms last year by the European Banking Authority (EBA), Germany’s regulator allowed one of the country’s lenders to keep back results of the test and registered an objection to the definition of capital.

“Germany didn’t let the EBA dictate any terms to its troubled banks; why would it now hand over controls to a new regulator?” said Nicholas Spiro in the report. Spiro, managing director of Spiro Sovereign Strategy, a London consulting firm specializing in sovereign credit risk, added, “The prospects of a new central authority are shaky at best.”

While Draghi “put his personal credibility on the line” and “would not have done so without being confident about his key constituency,” according to Erik Nielsen, global chief economist at UniCredit Bank in London, he also said in the report, “the ECB under Draghi does not like to mess around in the market, but if it sees a need, it will come with overwhelming force.”

Whether that force will be enough to overrule Germany remains to be seen, although others in the eurozone seem to be coming to accept the need for a drastic step of some kind.

Jean-Claude Juncker, who heads the group of eurozone finance ministers, was quoted saying in a weekend interview, “We have reached a decisive point. The world is talking about whether there will still be a eurozone in the next few months. We have to make abundantly clear with all available resources that we’re completely determined to guarantee the financial stability of the currency.” He added, “We have no time to lose.”

However, Moody’s said in Monday’s Credit Outlook, “These conflicting remarks [from the Bundesbank and from other eurozone finance ministers] illustrate the diverging views that have dogged the euro area authorities’ policy development and significantly contributed to the depth of the crisis.”

Clemens Fuest, an Oxford University economist who sits on an advisory panel for the German finance ministry, said in the report, “I’m skeptical that Weidmann would be easily convinced. I would certainly think that Draghi will try to reach some consensus here rather than go against Weidmann.”

Influence in the eurozone has shifted, however, since the election of President Francois Hollande of France, who has not been afraid to challenge Germany’s influence on policy in the bloc. In addition, Draghi has worked with Juncker, European Commission (EC) President Jose Manuel Barroso and EU President Herman Van Rompuy to map out a survival plan for the eurozone.